Causes & Consequences (Cambridge International IGCSE Economics)
Exam board Cambridge International · IGCSEUpdated 2024-06-13
Causes and Consequences of Market Failure
Spec point — With respect to public goods, merit and demerit goods, external costs and external benefits, abuse of monopoly power and factor immobility. Examples of market failure with respect to these areas only.
- Market Failure occurs when free market activity results in a less than optimum allocation of resources from the point of view of society
The Causes and Consequences of Market Failure
| Cause | Explanation | Consequences |
|---|---|---|
| Demerit Goods | - These are goods which have harmful impacts on consumers/society - They are often addictive - E.g. Gambling, alcohol, drugs, sugary foods/drinks | - They are over-provided in a market and their consumption often creates external costs - Governments often have to regulate these goods in such a way that they raise the prices and/or limit the quantities consumed |
| Merit Goods | - These are goods that are beneficial to society but consumers under-consume them as they do not fully recognise the private or external benefits - E.g. Vaccinations, education, electric cars | - They are under-provided in a market and their consumption generates both private and/or external benefits - Governments often have to subsidise these goods in order to lower the price and/or increase the quantities consumed |
| Public Goods | - Public goods are beneficial to society but would be under-provided by a free market as there is little opportunity for sellers to make profits from providing these goods/services as they are non-excludable and non-rivalrous in consumption - Good examples include national defence, parks, libraries and lighthouses | - Non-excludability refers to the inability of private firms to exclude certain customers from using their products. In effect, the price mechanism cannot be used to exclude customers e.g. street lighting - Non-rivalry refers to the inability of the product to be used up, so there is no competitive rivalry in consumption to drive up prices and generate profits for firms - Therefore, governments will often provide these beneficial goods themselves, and so they are called public goods |
| Abuse of Monopoly Power | - The development of monopoly markets is a natural outcome of a market system - Firms seek to eliminate competition by buying out competitors and increasing their ownership of factors of production - With less competition, firms can raise prices, reduce the choice available to consumers, or limit the supply | - The outcome is that goods/services are purposely under-provided in order to raise prices and profits - Governments often intervene to ensure that there is healthy competition in markets and sufficient provision of goods/services |
| Factor Immobility | - Factor immobility occurs when it is difficult for factors of production to move or switch between different uses/locations - The two main types of factor immobility are the geographical and occupational immobility of labour | - Factor immobility results an inefficient allocation of resources in a market (usually under-provision) - Governments often implement programs to reduce the factor immobility in order to raise production and output |
| External Costs and Benefits | - Externalities occur when there is an external cost or benefit on a third party not involved in the economic transaction - These impacts can be positive or negative - The price mechanism in a free market ignores these externalities - If these external costs/benefits were acknowledged, then the price and output in the market would be different | - A positive externality of consumption occurs when there is a positive external benefit in consumption, such as when electric vehicles are consumed CO2 emissions fall - A positive externality of production occurs when there is a positive external benefit in production, such as when managed pine forests produce timber but also increase CO2 absorption - A negative externality of consumption occurs when there is an external cost in consumption such as when the consumption of alcohol increases anti social behaviour - A negative externality of production occurs when there is an external cost in production such as when the production of electricity increases air pollution |
Exam Hint When explaining externalities, your syllabus focusses on the external costs and benefits. It does not specifically refer to negative/positive externalities of production or consumption. That language has been included here as it helps to deepen your understanding which will help you to better answer both MCQ and structured questions on market failure. You can use this economic language knowing it will enhance your answers.
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